Pop Quiz: Which interest rate is lower? 8.25% or Prime Rate?
If you answered anything other than “they are the same”, then you can understand first-hand why banks refer to Prime Rate by name instead of by number.
It’s a neat little piece of sales psychology that keeps people from recognizing their true cost of credit.
Prime Rate is based on the Fed Funds Rate and is pegged to be 3.000% higher. FFR is currently 5.250% (see chart at right) so Prime Rate is three percentage points higher, or 8.250%.
Since June 2004, Prime Rate has increased by 4.250% from 4.000% to today’s levels (again, see chart at right). During that time span, the interest rate paid on home equity lines of credit have increased by 4.250%, too. For many homeowners, this is surprising (and costly) news.
And it’s also one of the main reasons why Prime Rate is called by its name, and not by its value. Homeowners are less likely to pay attention.
For example, home equity lines of credit are based on Prime Rate and many homeowners know that their rate is “Prime + 0.500%”, or something similar. Many, however, are unaware of the actual number that is their interest rate.
As Prime Rate has increased, homeowners that aren’t paying attention to their mortgage(s) are carrying a household “blended” interest rate that may be much higher than anticipated.
What good is the 5.000% interest rate on the first mortgage if the second mortgage is clocking in at 9.000%? It may make sense to “rebalance” your loans to lower your overall payments because HELOCs are so much more expensive, relative to past years.
If you don’t know your household’s blended mortgage rate, or how changes to Prime Rate have impacted your monthly interest payment, ask your mortgage professional for help.